by Tetiana Kuzhda

TOPIC I. FUNDAMENTALS OF ECONOMIC FORECASTING

• What is forecasting?

• What is economic forecasting?

• Features of forecasting

• Significance of forecasting

• Limitations of forecasting

• Forecast types

• Forecasting methods

What will be covered?

• Forecast is a likely, scientifically well-grounded opinion about possible state of the events, objects or processes in the future.

• Forecast is a statement of the expected outcome of a given set of events or data.

• Economic forecast is a statement of future developments in business such as sales, expenditures, profits, etc.

Forecast definitions

• Forecasting is a process of making statements about events whose actual outcomes (typically) have not yet been observed.

• Forecasting is a process of predicting or estimating the future based on past and present data.

• Economic Forecasting is a process of making forecasts based on analysis of past trends and regularities of the economic processes, activities and data.

What is forecasting?

Steps of Economic Forecasting

Step 1 Determine the use of the forecast

Step 2 Identify the items to be forecasted

Step 3 Set the time limits of the forecast

Step 4 Data collection

Step 5 Select the forecasting model

Step 6. Forecast estimation

“The forecast”

Step 7. Make the forecast

The use of the forecast is caused by the following:

• who needs the forecast

• all entities (organizations, companies, enterprises, etc.) operate in the atmosphere of uncertainty

• decisions to be made affect future of the organization.

Step 1. Determine the use of the forecast

• economic processes (for example, inflation, demand, supply)

• company activities (for example, price, profit, income, costs)

• national economics (for example, gross domestic product, national income, export, import, external debt)

• social processes (for example, wage, salary, bonus fund, incentive fund, overtime payments)

Step 2. Identify the items to be

forecasted

• short-term forecast is the forecast for week, month, quarter and year

• medium-term forecast is the forecast from 1 to 3 years

• long-term forecast is the forecast over 3 years

Step 3. Set the time limits (time horizon)

of the forecast

is a term used to describe a process of preparing and collecting statistical data necessary to forecasting

Step 4. Data collection

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Primary data include:• internal company information (for example, data on the costs

of raw materials, costs of production, prices, income, net profit, sales and etc.)

• external information obtained from consumers, suppliers, distributors or economists-experts resulting personal interviews.

Secondary data include:• data collected by government statistics, private

organizations, specialized on collecting statistical data (for example, consulting agencies)

• data obtained resulting censuses, statistical surveys, and organizational records

• computer databases can be classified according to types of content: analytical, full-text, numeric, images, etc.

Data sources

Economic and statistical models can be:

• simple models help to make forecast depending on one factor (time)

• complex models help to make forecast depending on many factors

Step 5. Select the forecasting model

is a process of its checking (validating) on goodness of fit and statistical significance based on statistical coefficients

General rule: if the forecasting model is reliable and statistical significant, the forecast is accurate.

Step 6. Forecast estimation

means to calculate the quantitative forecast (using forecasting techniques and methods) that is a basis for making decisions by managers

Step 7. Make the forecast

• forecasting is concerned with future events;

• it shows the probability of happening of future events;

• it analysis past and present data;

• it uses statistical tools and techniques;

• it uses personal observations.

Characteristics or features of forecasting

Significance or importance of forecasting

• Forecasting provides relevant and reliable information about the past and present events and the likely future events.

• It gives confidence to the managers for making important decisions.

• It keeps managers active and alert to face the challenges of future events and the changes in the environment.

Limitations of forecasting

• 1) Collection and analysis of data about the past, present and future involve a lot of time and money. Therefore, managers have to balance the cost of forecasting with its benefits.

• 2) Forecasting can only estimate the future events. It cannot guarantee that these events will happen in the future. Long-term forecasts will be less accurate than short-term forecast.

• 3) Forecasting is based on past events (data). However, history may not repeat itself at all times.

• 4) Forecasting requires proper judgment and managers skills. Forecasts may go wrong due to bad judgment and skills on the part of some of the managers. Therefore, forecasts are subject to human error.

Limitations of forecasting• 5) Forecast always contains some mistake; it presence in the

forecast is objective and can not be eliminated by using the most advanced calculation techniques and methods.

• 6) All types of forecasting methods are founded on the statistical data processing by special methods (for example, extrapolation). In this case, forecast is based on identified trends and data in the past.

• 7) There is no universal forecasting method which can provide high quality of forecast. Selection of forecasting method should be based on detailed analysis of the current situation both inside the economic entity and beyond.

• 8) Any forecasting method is based on certain assumptions that can simplify the economic reality. If these assumptions are wrong, the forecasting will be wrong and on the contrary, if these assumptions are right, the forecasting will be accurate.

Forecast types

1. Economic forecast is a statement of predicting the movements of the economy. It includes

• Microeconomic forecasts are designed to predict the effects of change at the level of an industry or a firm.

• Macroeconomic forecasts are designed to predict the course of the aggregate economy and concentrate on variables such as interest rates, the rate of inflation, and the rate of unemployment.

Microeconomic forecast typesSales forecast is used to predict how many people will want

to buy a product or service from a company in a specific period. Sales forecasting is used in business planning, management decisions and marketing.

Demand forecast is the activity of estimating the quantity of a product or service that consumers will purchase. Demand forecasting may be used in making pricing decisions, in assessing future capacity requirements, or in making decisions on whether to enter a new market.

Revenue forecast is used to predict what money will be made by meeting the sales forecast. The revenue forecast is an assessment of the profit that a company might make providing a financial baseline to measure achievement of business strategy.

Forecast types

2. Technological forecast is a statement of predicting the future state of technology and the extent to its use

3. Political forecast is involved in the investigation and analysis of all areas of election

4. Demographic forecast is a statement of predicting the migration of the population, reproduction of labour by age composition, employment of working population

Forecast types by time horizon

• Short-term forecast is used in development of monthly, quarterly and annual plans

• Job scheduling, worker assignments

• Medium-term forecast is used to develop the tactical plans (1-3 years)

• Sales/production planning

• Long-term forecast is used to develop the strategic plans (over 3 years)

• New product planning

• Spot (or point) forecast includes a single predicted value. For example, after 6 months the price of a given product will grow by 10%.

• Interval forecast is used to predict the future, which offered a range, the range of predicted values. For example, after 6 months the price of a given product will grow by 10-15%.

Forecast types

• Qualitative forecast is based on subjective methods, intuition and managerial experience

• Quantitative forecast is based on mathematical tools, time series methods and causal models

Forecast types

Forecasting methods

are the set of techniques and ways of external and internal data analysis to make conclusion about possible state of the events, objects or processes in the future.

• Qualitative or expert methods are based on expert knowledge, competence and personal experience in the certain sphere of activity (for example, sphere of industry, branch of agriculture or field of law).

• Quantitative methods are based on mathematical tools (formulas and equations). These methods include time series methods and causal / econometric forecasting methods.

Example:

based on statistics on exports and imports, find the trade balance forecasts for 2014, if the predicted growth compared to 2013 for products of oil industry is 12,5%, for products of metal processing industry is 10,5%, for products of machine building industry is 11,2%, for products of dairy industry is 4,5%, for products of textile industry is 3%, for products of footwear industry is 6%; the predicted decline compared to 2013 for products of electronic industry is 5%, for products of heavy industry is 3,5%, for products of timber industry is 1,5%.

Table 1 – Statistics on exports and imports

Table 2 – Calculation results

Table 3 – Calculation results